If you’re new to investing, you might want to brush up on the basics of asset allocation, diversification and rebalancing. These three simple ideas can help you save more for retirement and other goals.
Stocks, bonds and cash vary in risk and reward
First, you need to know about the three basic asset classes: stocks, bonds and cash or stable value.
These are shares of ownership in a public company. Stocks carry greater risks than bonds and cash/stable value options. Throughout history, stocks have offered the greatest potential for long-term growth.
Bonds are IOUs issued by a corporation, the government, or its agencies. The issuer promises to pay bondholders a stated rate of interest and the principal when the bond matures. Bonds offer moderate risk and lower returns than stocks.
Cash or stable value
This is an investment that seeks to preserve principal, provide consistent returns, and remain liquid. They offer low investment risk and lower returns.
Diversifying also helps balance your portfolio
When you diversify, you invest in a variety of asset classes to help balance risk and return. A simple example is an account that holds a stock fund, a bond fund and a cash fund. If one part of your portfolio is doing well and another is losing value, the gains help offset the losses. It is also possible to diversify within an asset class (an example is choosing a large-cap stock fund and a small-cap stock fund).
Asset allocation helps smooth ups and downs
This idea works with diversification. It’s how you choose to divide your investments among asset classes. You determine your asset allocation by considering your risk tolerance and the amount of time you have until you retire (your “time horizon”). A more aggressive portfolio that has a higher level of exposure to risk will be more invested in stocks, while a more conservative portfolio will have more bonds or cash/stable value.
Please note that diversification and asset allocation cannot guarantee a profit or protect against investment loss.